If you were to ask for the growth of Managed Futures assets in 2015, you might get different answers depending on who you ask. Barclayhedge will tell you $8.5 Billion, we think that number is more about $10.5 Billion, and a third party recently made the claim of as high as $30 Billion at a recent conference. Being the Managed Futures nerds that we are, this certainly caught our interest.

overheard at @hfmweek chicago summit – of Record $30 Billion new assets into ctas in 2015, $27 billion into just 8 managers

We’ll take the speaker at his word and assume those numbers were based on some hedge fund inflows report or another – but it got us to thinking of how much of the total assets (not just inflows) are controlled by the largest firms. Back in 2013, we discovered the 35 largest CTAs controlled 65% of the AUM, and it turns out it’s only gotten worse.

To find the answer this time round, we took all of the managers in the Barclayhedge managed futures database that have reported returns in 2016, then removed distinctly non managed futures hedge funds ,aka Bridegwater, to arrive at a universe 263 managers controlling 733 programs. We then summed up the assets to see just how top heavy the space is.

The answer is… it is very top heavy, with the top 5% of managers (just 13 firms) controlling 66% of the total assets, $166 Billion. By the time you get to the top 20% of managers, there’s only $19 Billion left in AUM for 210 managers. Here’s the breakdown:

This isn’t a new problem… but it does seem to be getting worse, with the largest managers checking the right boxes to get the largest allocations in a self-fulfilling circle, leading all the way to the bank. Investors, meanwhile, may be doing themselves a disservice in boxing themselves into a smaller and smaller universe of managers who can meet asset thresholds and stringent operational due diligence tests, forgetting perhaps – that bigger is not better in the managed futures space – with bigger leading to problems in terms of market impact, position limits, and tradeable markets (larger managers portfolios tend to be more heavily skewed towards financial instruments away from commodities).

At the same time, we’re hearing from more and more investors that they desire emerging managers and the often higher returns they can offer (even if it comes with a wider dispersion of returns – more on that in an upcoming whitepaper). But that’s not what’s happening according to the stats. According to the stats, that seems to be just lip service and a ‘wish’ of large investors instead of an actual allocation plan.

For now, we seem destined to watch the largest managers continue to get larger until…. something like – closures, performance flattening, underperformance due to financials exposure, etc – happens to shift investors wallets, not just their mindsets.

We’ve been waiting… and waiting… and waiting… for the markets. to. finally. move. With the election over, we’re now seeing it unravel. The U.S. Dollar Index is at levels not seen since 2003, Copper has roared up 20% in a week, and Gold is getting crushed. And that short list doesn’t include the biggest “market” – the U.S. stock market’s push to new all-time highs.

It’s time like these where logging into your investment account is a great idea if you’re a firm believer of the “buy, hold, and forget” club. What’s not to like? We all know about the market being up big since the 2009 lows, but now the market is up roughly 50% from its 2007 peak and looks as though it’s showing signs of breaking out of a 16-year range. It’s rainbows and lollipops all around…

…except in the world of Alternatives. Sure – there’s been an explosion of assets into alternatives since the 2008-2009 financial crisis. Sure, they are developing ever new and innovative ways of finding alpha or offering cheap alternative beta in the markets. But for all the effort, nobody seems to be able to keep up with the mighty US stock market. It seems easier to just buy a low-cost index fund.

Which got us to thinking. How much do stocks need to outperform alternatives in order for the long term benefit of alternatives to be made insignificant? In short, when is the excess return worth the increased risk? For all of those who decry hedge funds for underperforming stocks over the past few years – the answer is not very much. They seem to think a year or two of stocks outperforming stocks + alternatives means there’s no need for the diversification. Raise your hand if you’ve read an article about the massive shift into passive investments recently, or such and such pension fund dropping hedge funds because they aren’t seeing the value.

So what’s going on? Are alternatives no longer needed, or are lots of people suffering from a massive dose of recency bias? We decided to put the numbers to the theory, comparing a Diversified portfolio (36% stocks, 24% bonds, 40% Managed Futures) against a simple 60/40 portfolio going back to 2011, 2006, and the start of the millennium – 2000.

Given the headlines, it should be no surprise that the past five years show the basic 60/40 portfolio out performing a portfolio with alternatives. It would be hard to argue against complex alternatives investments and the wisdom of just sticking with simple passive indexing without such a graph.

The portfolio with alternatives underperformed a traditional portfolio just about the entire time, reminding us of an old line from the hoops classic Hoosiers: “Sun don’t shine on the same dog’s ass every day, but, mister you ain’t seen a ray of light since you got here.” Here are the stats for those into the nitty gritty.

So why has there been such growth and interest in Alternatives? Look no further than the comparison between a traditional portfolio and one containing alternatives over the past 10 years, going back through the financial crisis. Now, these two “lines” have ended up at essentially the same place over 10 long years, but just like you and that hippy cousin at Thanksgiving, the paths that were taken to get there were quite different.

(Disclaimer: Past performance is not necessarily indicative of future results)

While the “lines” might not do the difference between these two paths all that much justice, we can really see the benefits of an alternatives allocation in the statistics – with the max drawdown roughly cut in half, and the volatility about 2/3 that of the 60/40 portfolio. But this just begs the question: is a savings of 16% on the downside over the long term, worth an underperformance of 16% over the short term (past 5 yrs).

We might rush to say this is a wash, with the 16% savings offsetting the 16% loss, and the 10-year chart sort of bears this out with both strategies finishing around the same place. But it’s a bit more nuanced than that. Ask yourself whether you panicked during the 2008 crisis. Ask yourself how much more likely you’d be to throw in the towel when your portfolio is down -30% versus -15%. It’s easy to say you’re sticking with passive investing while we’re here at all time highs -it’s quite another when you’ve lost a third of your investment account and staring at world markets falling 50% or more during a crisis. What the stats don’t show is the diversified portfolio’s ability to keep you in the game… to keep you from getting out at the wrong time.

Which brings us to the very long term, looking back to the start of the SocGen CTA index in 2000.

(Disclaimer: Past performance is not necessarily indicative of future results)

And this – my friends – is why alternatives are worth it. Unless you’re getting started when you’re 85, investing isn’t a 5-year test. It’s hardly even a 10-year test. We’re talking 25, 50, and even 75 years of assets at work in the “markets” for some people, where the benefits of compounding and diversification show up more and more the longer you’re allowing them to work.

And what benefits they are, with the return higher, the volatility lower, and max drawdown still roughly half of what it is in a non-diversified portfolio. Past performance is not necessarily indicative of future results, and that’s the whole point. Alternatives may look nothing like their return stream since 2000, but neither may stocks. The non-correlation and mixture of the two are what makes it work over the long term.

In the meantime, we’ll always have periods of underperformance and over performance and everything in between as assets cycle into and out of beneficial market environments, leading to broad proclamations that hedge funds are dead, stock markets are broken, and so forth and so on. But those with a longer view see something different. They see non-correlation in action – with different return drivers producing different looking return streams over short periods of time. They see better risk adjust performance over the long term even when employing a strategy that is underperforming in the short term.

The Commodity Futures Trading Commission (CFTC) has extended the comment period on its proposed amendments to Regulation 4.22, which concerns the Annual Report that each commodity pool operator registered or required to be registered with the CFTC must distribute for each commodity pool that it operates.

There’s been so many words written about the redemptions and outflows of Hedge funds over the past week (here, here, and here), we didn’t think it was necessary to add ours. Then, Preqin released the money flows of Hedge Funds as well as Managed Futures (CTAs) thus far in 2016, and we simply couldn’t resist.

Meanwhile, CTA funds that use futures contracts boosted assets under management by 11% with inflows of $17 billion.

For the sake of consistency, we’re using Preqin’s numbers, while there were other databases reporting slightly more and slightly less. What we found particularly interesting wasn’t even the striking difference of money flows in Managed Futures compared to their cousin, Hedge Funds, but how much more money Managed Futures could be seeing the rest of 2016.

Say what you want about underperformance, fees, and saturation, but it seems to us that investors are smart enough to see the forest (Managed Futures) for the trees (Hedge Funds).

Alternative Investments are becoming more and more the place investors turn to find diversification for their portfolios. Look no further than a recent PIMCO piece showing Morningstar data from the start of 2015 to May 2016, where managed Futures and multi-strategy mutual funds saw roughly $37 Billion flow into the space.

Of course, these Morningstar categories are very broad, covering a lot of stuff we might not even put into the Alternatives bucket, but that’s for another post (in fact, that’s covered in this whitepaper – check it out: “Why Alternatives.”)

And understanding exactly what you’re getting in the Alternatives space is as important as ever. Take for example, this chart from PIMCO’s piece, showing the Managed Futures and Multi-Strategy categories broken down by their equity beta. If need a quick refresher, beta measures how much an investment moves when the stock market moves. A beta of 1.00 means they’ll have about the same volatility, while greater than 1 means more volatile, and less than 1 less volatility. Less than zero means you’ll have more or less volatility depending on the reading but in the opposite direction. Suffice to say a true diversifier should have a very low, if not negative, beta measurement – so that it isn’t moving in tandem with stocks.

While Pimco felt both categories are doing a good job of diversifying, with both having more than 80% of their funds with betas less than 0.4 – we were a little more interested in how 80% of managed futures has an equity beta of less than 0.1! And nearly half with negative betas. To us, this doesn’t show how both categories are good diversifiers, it shows how managed futures is a great diversifier.

Finally, they finish with some analysis of each category during two recent sell off periods (Aug-Sep 2015 and Jan-Feb 2016). Our takeaway here, again, is that multi-strategy is more equity-like then many would probably assume, losing money right along stocks in both periods, no matter their equity beta.

In contrast, Managed Futures mutual funds were up between 2% and 7% during the Jan-Feb stock market downturn across all of their beta ranges; while between up +1% and down -5% in the earlier down market.

The lesson here is that non correlation does not equal negative correlation. Many expect their non-correlated investment to go up while stocks go down – but that won’t always be the case. Non correlated means they’ll do different things, on average! That means one time down, one time up, one time sideways during down markets, and so on – to average out as totally different performance during market downturns. Any one down period, and especially very short ones such as the two listed here, may result in performance you didn’t see coming. That mismatch with your expectations can be particularly exasperated if in a high beta multi-strategy fund which will act way more like the general stock market than their name would entail.

P.S. – Looking for a managed futures mutual fund? Check out the following:

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DISCLAIMER

Forex trading, commodity trading, managed futures, and other alternative investments are complex and carry a risk of substantial losses. As such, they are not suitable for all investors. You should not rely on any of the information as a substitute for the exercise of your own skill and judgment in making such a decision on the appropriateness of such investments.

The entries on this blog are intended to further subscribers understanding, education, and - at times - enjoyment of the world of alternative investments through managed futures, trading systems, and managed forex. Unless distinctly noted otherwise, the data and graphs included herein are intended to be mere examples and exhibits of the topic discussed, are for educational and illustrative purposes only, and do not represent trading in actual accounts. Opinions expressed are that of the author.

The mention of specific asset class performance (i.e. +3.2%, -4.6%) is based on the noted source index (i.e. Newedge CTA Index, S&P 500 Index, etc.), and investors should take care to understand that any index performance is for the constituents of that index only, and does not represent the entire universe of possible investments within that asset class. And further, that there can be limitations and biases to indices such as survivorship and self reporting biases, and instant history.

The performance data for various Commodity Trading Advisor ("CTA") and Commodity Pools are compiled from various sources, including Barclay Hedge, RCM's own estimates of performance based on account managed by advisors on its books, and reports directly from the advisors. These performance figures should not be relied on independent of the individual advisor's disclosure document, which has important information regarding the method of calculation used, whether or not the performance includes proprietary results, and other important footnotes on the advisor's track record.

The mention of general asset class performance (i.e. managed futures did well, stocks were down, bonds were up) is based on RCM’s direct experience in those asset classes, estimates of performance of dozens of CTAs followed by RCM, and averaging of various indices designed to track said asset classes.

The mention of market based performance (i.e. Corn was up 5% today) reflects all available information as of the time and date of the publication.

The owner of this blog, RCM Alternatives, may receive various forms of compensation from certain investment managers highlighted and/or mentioned within the blog, including but not limited to retaining: a portion of trade commissions, a portion of the fees charged to investors by the investment managers, a portion of the fees for operating a fund for the investment managers via affiliate Attain Portfolio Advisors, or via direct payment for marketing services.

Managed Futures Disclaimer:

Past Performance is Not Necessarily Indicative of Future Results. The regulations of the CFTC require that prospective clients of a managed futures program (CTA) receive a disclosure document when they are solicited to enter into an agreement whereby the CTA will direct or guide the client’s commodity interest trading and that certain risk factors be highlighted. The disclosure document contains a complete description of the principal risk factors and each fee to be charged to your account by the CTA.

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Disclaimer

Forex trading, commodity trading, managed futures, and other alternative investments are complex and carry a risk of substantial losses. As such, they are not suitable for all investors.
The mention of market based performance (i.e. Corn was up 5% today) reflects all available information as of the time and date of the publication.